The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Tuesday, May 7, 2013

Before taking on responsibility for supervising EU banks, ECB wants to know if there are losses being hidden by banks

The Telegraph reports that before it takes on responsibility for supervising the EU's banks, the ECB wants to do a review of their on and off-balance sheet exposures to be sure that there are no losses being hidden by the banks.

The frozen interbank unsecured lending market has been the canary in the coal mine signaling that banks are hiding losses and the issue of solvency has not been addressed. The interbank unsecured lending market acts as the canary because banks with deposits to lend won't lend to banks looking to borrow unless the bank looking to lend can figure out the borrowing bank will repay the loan.

It is astonishing that we could be 5+ years into a bank solvency led financial crisis and the answer to the question of which banks are solvent (market value of assets greater than book value of liabilities) and which are insolvent is still not known.

So why hasn't bank solvency been addressed given that banks are designed to continue operating even when they are insolvent?

The primary reason why is banker cash bonuses. If each bank had to disclose the losses hidden on and off their balance sheets, there would be no banker cash bonuses for the foreseeable future as all earnings would be retained to rebuild bank book capital levels.

It is also astonishing that by saying that it wants to review each bank's exposures for hidden losses, the ECB is effectively saying the financial regulator run bank solvency stress tests are a total sham.

“The first thing that the ECB will have to do when they take on their supervisory task is to have an asset-quality review of the main banks that will be under their supervision and I think very soon after that all the other banks in Europe as well because there is still the risk of contamination between banks,” Mr Dijsselbloem said.

“The outcome of that asset quality review we don't know yet, but it might be worrying. It might be worrying for some banks in some countries. We don’t exactly know. What I do know is that when we do have an outcome that is worrying, we need to have the instruments to deal with the problems.”...

Yves Mersch, an ECB executive board member, confirmed that the new supervisor would check bank balance sheets to reveal any concealed dangers in the quality of assets before taking charge.

“Before we start working, we need to know what is on the balance sheet of these banks,” he said.

Not only the ECB, but every market participants needs to know what is on and off the balance sheet of the EU banks.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.